Finance Suggested

Short Notes
Compilation
(June 2015-December 2022)

Compiled By: Pradip Khatri

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1. Social cost benefit analysis
Social cost benefit analysis is the method of evaluating the use of public fund. It considers
monetary as well as non-monetary returns. Large amount of public fund is committed every year
for various public projects. Analysis of such projects has to be done with reference to social costs
and benefits. Such projects are not merely considered based on commercial returns, instead
considered for various social returns in the form of employment generation, access to market,
increase in life styles, access to basic requirements such as health, education, drinking water. So,
such projects are analyzed based on what social benefits that particular project will provide.
Based on such returns decision as to whether to implement projects or not is made by the
competent authorities
2. Reverse takeover
A reverse takeover or reverse merger takeover (reverse IPO) is the acquisition of a public
company by a private company so that the private company can bypass the lengthy and complex
process of going public. The transaction typically requires reorganization of capitalization of the
acquiring company. Sometimes, it might be possible that a company continuously trades as a
public company but has no or very little assets and what remains only its internal structure and
shareholders. This type of merger is also known as "back door listing".
Reverse merger brings following benefits to acquiring private company:
• Easy capital market accessibility
• Less time consuming and less cost for becoming public
• Benefits of tax on carry forward losses of acquired company

This concept is yet to be implemented in Nepalese Capital Market as no such publicly traded
company has been acquired by the private company till date.

3. Financial tapering
The word tapering in financial terms is increasingly being used to refer to the reduction of the
Federal Reserve's quantitative easing, or bond buying program. Tapering activities is primarily
aimed at interest rates and investors' expectations of what those rates will be in the future.
These can include conventional central bank activities, such as adjusting the discount rate or
reserve requirements, or more unconventional ones, such as quantitative easing (QE). Central
banks can employ a variety of policies to improve growth, and they must balance short-term
improvements in the economy with longer-term market expectations. If the central bank tapers
its activities too quickly, it may send the economy into a recession. If it does not taper its
activities, it may lead to high inflation. Tapering is best known in the context of the Federal
Reserve's quantitative easing program. In reaction to the 2007 financial crisis, the Federal
Reserve began to purchase assets with long maturities to lower long-term interest rates. This
activity was undertaken to entice financial institutions to lend money, and it began when the
Federal Reserve purchased mortgage-backed securities.
4. Financial leverage
Financial Leverage may be defined as "the use of funds with a fixed cost in order to increase
earnings per share". In other words, it is the use of company funds on which it pays a limited
return. Financial leverage involves the use of funds obtained at a fixed cost in the hope of
increasing the return to common stockholders. Degree of the financial leverage is the ratio of the

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 percentage increase in earnings per share (EPS) to the percentage increase in earnings before
interest and taxes (EBIT).
5. Reasons for changes in working capital
The changes in the level of working capital occur for the following 3 basic reasons:
• Changes in Sales and operating expenses: The first factor causing a change in the
working capital requirement is a change in the sales and operating expenses. The
changes in this factor may be due to three reasons: First, there may be a long-run trend
of change. For instance, the price of a raw material, say oil, may constantly rise,
necessitating the holding of a large inventory. The second trends would mainly affect the
need for permanent current assets. In the second place, cyclical changes in the economy
leading to ups and downs in business activity influence the level of working capital, both
permanent and temporary. The third source of change is seasonality in sales activity.
Seasonality-peaks and troughs-can be said to be the main source of variation in the level
of temporary working capital. The change in sales and operating expenses may be either
in the form of an increase or decrease. An increase in the volume of sales is bound to be
accompanied by higher levels of cash, inventory and receivables. The decline in sales has
exactly the opposite effect a decline in the need for working capital. A change in the
operating expenses rise or fall has a similar effect on the levels of working capital.
• Policy Changes: The second major cause of changes in the level of working capital is
because of policy changes initiated by the management. There is a wide choice in the
matter of current assets policy.
• Technological changes: Finally, technological changes can cause significant changes in
the level of working capital. If a new process emerges as a result of technological
developments, which shortens the operating cycle, it reduces the need for working
capital and vice versa.
6. Clean overdraft
A clean overdraft refers to an advance by way of overdraft facility, but not backed by any tangible
securities. Hence request for clean advances are entertained only from parties which are
financially sound and reputed for their integrity. Bank has to rely upon the personal security of
the borrowers. Some factories to be considered by the banks before granting clean ODs are (a)
past operations of the party (b) turnover in the accounts (c) satisfactory dealings for
considerable period (d) reputation in the market. As a safeguard, banks take guarantee from
other persons who are credit worthy before granting this facility. A clean advance is generally
granted for a short period and must not be continued for long.
7. Virtual banking and its advantages
Virtual Banking refers to the provision of banking and related services through the use of
information and communication technologies (ICT) without direct resources to the bank by the
customers. The advantages of virtual banking services are as follows:
• Lower cost of handling transaction
• The increased speed of response to the customer requirements
• Lower cost of operating branch network along with reduced staff costs
• Leads to cost and service efficiency

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8. Dematerialization of securities
Dematerialization is the process of converting physical shares into electronic format. An investor
who wants to dematerialize his physical shares need to open a demat account with Depository
participant. Investor surrenders his physical shares and in turn gets electronic shares in his
demat account. Depository Participant (DP) is the market intermediary through which investors
can avail the depository services. Depository Participant provides financial services and includes
organizations like banks, brokers, custodians and financial institutions. Dealing in Demat is
beneficial for investors, brokers and companies alike. It reduces the risk of holding shares in
physical format from investor's perspective. It's beneficial for brokers as it reduces the risk of
delayed settlement and enhances profit because of increased participation.
Dematerialization is the process of converting physical shares into electronic format. An investor
who wants to dematerialize his physical shares need to open a demat account with Depository
participant. Investor surrenders his physical shares and in turn gets electronic shares in his
demat account. Depository Participant (DP) is the market intermediary through which investors
can avail the depository services. Depository Participant provides financial services and includes
organizations like banks, brokers, custodians and financial institutions. Dealing in Demat is
beneficial for investors, brokers and companies alike. It reduces the risk of holding shares in
physical format from investor's perspective. It's beneficial for brokers as it reduces the risk of
delayed settlement and enhances profit because of increased participation.
9. Effect of leverage on Capital Turnover and Working Capital Ratio
An increase in sales improves the net profit ratio, raising the Return on Investment (R.O.I) to a
higher level. This however, is not possible in all situations; a rise in capital turnover is to be
supported by adequate capital base. Thus, as capital turnover ratio increases, working capital
ratio deteriorate, thus, management cannot increase its capital turnover ratio beyond a certain
limit. The main reasons for a fall in ratios showing the working capital position due to increase in
turnover ratios is that as the activity increases without a corresponding rise in working capital,
the working capital position becomes tight. As the sales increases, both current assets and
current liabilities also increase but not in proportion to current ratio. If current ratio and acid test
ratio are high, it is apparent that the capital turnover ratio can be increased without any
problem. However, it may be very risky to increase capital turnover ratio when, the working
capital position is not satisfactory.
10. Credit Rating
Credit rating essentially reflects the probability of timely repayment of principal and interest by a
borrower company. It indicates the risk involved in a debt instrument as well its qualities. Higher
the credit rating, greater is the probability that the borrower will make timely payment of
principal and interest and vice-versa. It has assumed an important place in the modern and
developed financial markets. It is a boon to the companies as well as investors. It facilitates the
company in raising funds in the capital market and helps the investor to select their risk-return
trade-off. By indicating credit-worthiness of a borrower, it helps the investor in arriving at a
correct and rational decision about making investments. Credit rating system plays a vital role in
investor protection. Fair and good credit ratings motivate the public to invest their savings. As a
fee-based financial advisory service, credit rating is obviously extremely useful to the investors,
the corporate (borrowers) and banks and financial institutions. To the investors, it is an indicator
expressing the underlying credit quality of a security to be floated for in the market. The investor

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 is fully informed about the company as any effect of changes in business/economic conditions
on the company is evaluated and published regularly by the rating agencies. The Corporate
borrowers can raise funds at a cheaper rate with good rating. It minimizes the role of the 'name
recognition' and less known companies can also approach the market on the basis of their
rating.
11. Sensitivity Analysis
The net present value or Internal Rate of Return of a project is determined by analyzing the
after-tax cash flows arrived at by combining forecasts of various variables like Sales volume, unit
selling price, unit variable cost, fixed cost etc. It is difficult to arrive at an accurate and unbiased
forecast of each variable. It can't be certain about the outcome of any of these variables. The
reliability of the NPV or IRR of the project will depend on the reliability of the forecasts of
variables underlying the estimates of net cash flows. To determine the reliability of the project's
NPV or IRR, we can work out how much difference it makes if any of these forecasts go wrong.
We can change each of the forecasts, one at a time, to at least three values: Pessimistic,
expected and optimistic. The NPV of a project is recalculated under these different assumptions.
The method of recalculating NPV or IRR by changing each forecast is called Sensitivity Analysis.
Sensitivity Analysis is a way of analyzing change in the project's NPV or IRR for a given change in
one of the variables. It indicates how sensitive a project's NPV or IRR is to changes in particular
variables. It basically examines the sensitivity of the variables underlying the computation of
NPV or IRR rather than attempting to quantify risk. It can be applied to any variable which is an
input for the after-tax cash flows. It can be conducted with regard to volume, price, costs etc.
12. Agency cost of equity and debt
Agency cost refers to the cost incurred by a firm because of the problems associated with the
different interests of management and shareholder and the information asymmetry that exists
between the principal (shareholders) and the agent (management).
• Agency Cost of Equity
The agency cost of equity arises because of the difference in interests between the
shareholders and the management. As long as the management ‘s interests diverge from
that of the shareholders, the shareholders will have to bear this cost. Management may
be tempted to take suboptimal decisions that may not work towards maximizing the
value for the firm. Any measures implemented to oversee and prevent this will have a
cost associated with it. So, the agency costs will include both, the cost due to the
suboptimal decision, and the cost incurred in monitoring the management to prevent
them from taking these decisions
• Agency Cost of Debt
The agency cost of debt arises because of different interests of shareholders and
debtholders. Assume that the management is in favor of the shareholders. If so, the
management can in many ways transfer the wealth to the shareholders and leaving
debtholders empty handed. Anticipating such activities, the debt-holders will take
various preventive measures to disallow management from doing so. The debt holders
may do so in the form of higher interest rates to protect themselves from the losses.
Alternatively, they may impose restrictive covenants

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13. Debt securitization
Securitization is a process in which illiquid assets are pooled into marketable securities that can
be sold to investors. The process leads to the creation of financial instruments that represent
ownership interest in, or are secured by a segregated income producing asset or pool of assets.
These assets are generally secured by personal or real property such as automobiles, real estate,
or equipment loans but in some cases are unsecured.
For example, a finance company has issued a large number of car loans. It desires to raise further
cash so as to be in a position to issue more loans. One way to achieve this goal is by selling all
the existing loans, however, in the absence of a liquid secondary market for individual car loans,
this may not be feasible. Instead, the company pools a large number of these loans and sells
interest in the pool to investors. This process helps the company to raise finances and get the
loans off its Balance Sheet. These finances shall help the company disburse further loans
14. Four kinds of floats with reference to cash management
Four Kinds of Float with reference to Management of Cash are as follows:
• Billing Float: The time between the sale and the mailing of the invoice is the billing float.
• Mail Float: This is the time when a cheque is being processed by post office, messenger
service or other means of delivery.
• Cheque processing float: This is the time required for the seller to sort, record and
deposit the cheque after it has been received by the company.
• Bank processing float: This is the time from the deposit of the cheque to the crediting of
funds in the seller ‘s account.
15. Activities covered by Treasury Management
Treasury Management is concerned about the efficient management of liquidity and financial
risk in business. Main activities which are covered by Treasury Management are as follows:
• Cash management: Treasury management in a business organization is concerned about
the efficient collection and repayment of cash to both insiders and to third parties.
• Currency management: It manages the foreign currency risk, exchange rate risks etc. It
may advise on the currency to be used when invoicing overseas sales.
• Funding management: Responsible for planning and sourcing firm ‘s short-, medium-
and long-term cash needs. It participates in capital structure, forecasting of future
interest and foreign currency rates decision-making process.
• Banking: Maintains good relations with bankers and carry out initial negotiations with
them for any short-term loan.
• Corporate finance: It advises on aspects of corporate finance including capital structure,
mergers and acquisitions
16. Bridge finance
Bridge finance refers, normally, to loans taken by the business, usually from commercial banks
for a short period, pending disbursement of term loans by financial institutions. Normally it takes
time for the financial institution to finalize procedures of creation of security, tie-up participation
with other institutions etc. even though a positive appraisal of the project has been made.
However, once the loans are approved in principle, firms in order not to lose further time in
starting their projects arrange for bridge finance. Such temporary loan is normally repaid out of
the proceeds of the principal term loans. It is secured by hypothecation of moveable assets,

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 personal guarantees and demand promissory notes. Generally, rate of interest on bridge finance
is higher as compared with that on term loans
17. Trading on equity
The term trading on equity means debts are contracted and loans are raised mainly on the basis
of equity capital. Those who provide debt have a limited share in the firm’s earnings and hence
want to be protected in terms of earnings and values represented by equity capital. Since fixed
charges on debts do not vary with firm’s earnings before interest and tax, a magnified effect is
produced on earnings per share called financial leverage. Whether the leverage is favorable, in
that increase in earnings per share more proportionately to the increased earnings before
interest and tax, depends on the profitability of the investment proposal. If the rate of returns on
investment exceeds their explicit cost, financial leverage is said to be positive.
18. Crowd funding
Crowd funding is the practice of raising money from a large number of individuals for the
purposes of financing a project, venture, business or cause. Traditionally, crowd funding has
been carried out via subscriptions, benefit events and door-to-door fundraising. However, today
the term is typically associated with raising money through website platforms, which allows
crowdfunding to reach a larger pool of potential funders.
Crowdfunding usually takes place on a light-touch online platform rather than through banks,
charities or stock exchanges. The business or individual seeking finance will typically produce a
pitch for their business, project or venture, which is then uploaded to the online platform with
the aim of attracting as many loans, contributions and investments as possible. Websites such as
Kickstarter, Seedrs and Crowdcube are examples of the available online platforms, which enable
project initiators to reach a pool of thousands, if not millions, of potential funders.
19. Trade credit
Trade credit refers to an arrangement whereby the supplier of the raw materials, components,
stores and spare parts, finished goods, allow the customers to pay their outstanding balances
within the credit period allowed by them. Generally, suppliers grant credit for a period of three
to six months and thus provide short term funds to finance current assets. The availability of
trade credit depends upon various factors such as nature and size of the firm, status of the firm
(i.e., credit worthiness), activity level of the firm, policy of trade credit suppliers, prevailing
economic conditions etc. The major limitations of trade credit include ready availability, absence
of issue formalities etc. The major limitation of trade credit is that it involves loss of cash
discount, which could be earned if payments were made within seven to ten days from the date
of purchase. This loss is regarded as the cost of trade credit.
20. Ageing schedule in the context of monitoring of receivables
An important means to get an insight into collection pattern of debtors is the preparation of
their ‘Ageing Schedule’. Receivables are classified according to their age from the date of
invoicing, e.g., 0 – 30 days, 31 – 60 days, 61 – 90 days, 91 – 120 days and more. The ageing
schedule can be compared with earlier month’s figures or the corresponding month of the
earlier year. This classification helps the firm in its collection efforts and enables management to
have a close control over the quality of individual accounts. The ageing schedule can be
compared with other firms also.

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21. Triple bottom line reporting
The Triple bottom line reporting concept in accounting emerged in mid-1990s with a framework
having three parts: Social, environmental and financial or people, planet and profit. It refers to
the need for companies to focus on value and benefits together with the damages (if any)
provided by the company in terms of:
• Economic Value (Company’s Success)
• Environmental value and (Protection to the environment)
• Social value (Social responsibility)

Providing stakeholders with corporate performance data in each of these areas is known as
triple bottom line reporting.

22. Liquidity preference theory

The liquidity preference theory of the term structure addresses the shortcomings of the pure
expectations theory by proposing that forward rates reflect investors' expectations of future spot
rates plus a liquidity premium to compensate them for exposure to interest rate risk.
Furthermore, the theory suggests that this liquidity premium is positively related to maturity: a
25-year bond has a larger liquidity premium than a 5-year bond. The liquidity theory says that
forward rates are biased estimates of the market's expectation of future rates because they
include a liquidity premium. Therefore, a positive-sloping yield curve may indicate that either:
(1) the market expects future interest rates to rise; or (2) that rates are expected to remain
constant (or even fall), but the addition of the liquidity premium results in a positive slope. A
downward-sloping yield curve indicates falling short term rates according to the liquidity
preference theory. The size of the liquidity premiums need not be constant over time. They may
be larger during periods of greater economic uncertainty, when risk aversion among investors is
higher.
23. Capital rationing
Capital rationing is the decision process used to select capital projects when there is a limited
amount of funding available. Rationing may also be imposed when there is enough funding, but
management is restricting it from certain parts of the business in order to emphasize
investments in other areas. Capital rationing means the utilization of existing funds in most
profitable manner by selecting the acceptable projects in the descending order or ranking with
limited available funds. The firm must be able to maximize the profits by combining the most
profitable proposals. Capital rationing may arise due to.
• The imposition of internal constraints, which are often imposed when managerial
resources are limited, known as soft capital rationing.
• Hard capital rationing occurs when external limits are set, perhaps because of scarcity of
financing, high financing costs or restrictions on the amount of external financing an
organization can seek

IRR or NPV are the best basis of evaluation even under Capital Rationing situations. The
objective is to select those projects which have maximum and positive NPV. Preference
should be given to interdependent projects. Projects are to be ranked in the order of NPV
(Profitability Index). Where there is multi-period Capital Rationing, Linear Programming

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 Technique should be used to maximize NPV. In times of Capital Rationing, the investment
policy of the company may not be the optimal one.

In nutshell, Capital Rationing leads to:

• Allocation of limited resources among ranked acceptable investments.

• This function enables management to select the most profitable investment first.
• It helps a company use limited resources to the best advantage by investing only in
the projects that offer the highest return.
• Either the internal rate of return method or the net present value method may be
used in ranking investments
24. Perpetuity
Perpetuity is a stream of payments or type of annuity that starts payment on fixed date and such
payments continue forever or perpetually. Often preference share which pays a dividend is
considered as a form of perpetuity. However, one must assume that the firm does not go
bankrupt or is otherwise impended for making timely payments. Specifically fixed coupon
payments on permanently invested (irredeemable) sums of money are the core examples of
perpetuities. The value of the perpetuity is finite because receipts that are anticipated far in the
future have extremely low present value. Further, because the principal is never repaid, there is
no present value for the principal. Therefore, the value of perpetuity is simply the coupon
amount over the appropriate discount rate.
25. Limitations of using Retained Profit
The major limitations of using retained profits as a source of financing are as follows:
• Available only to Profitable Companies—This source of financing is available only to
profitable companies
• Concentration of Economic Power—Growth of companies through accumulation of
reserves leads to concentration of economic power
• Involves Opportunity Cost—It involves opportunity cost (i.e., the return which the
shareholders could have earned if the profits were distributed). The management
sometimes does not consider this cost while declaring dividend to equity shareholders.
• Danger of Over-capitalization—There is always a danger of over-capitalization if the
company retains profits on continuous basis year after year without requirements of
funds for profitable investments.
26. Limitation of Financial Ratios
The limitations of financial ratios are listed below:
• Diversified product lines: Many businesses operate a large number of divisions in quite
different industries. In such cases, ratios calculated on the basis of aggregated data
cannot be used for inter-firm comparison.
• Financial data are badly distorted by inflection: Historical costs values may be
substantially different from true values. Such distortion of financial data is also carried in
the financial ratios
• Seasonal factors may also influence financial data
• To give a good shape to the popularly used financial ratios (like current ratio, DE ratios
etc.), the business may make some yearend adjustments. Such window dressing can

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 change the character of financial ratios which would be different had there been no such
changes.
• Difference in accounting policies and accounting period: It can make the accounting data
of two firms non-comparable as also the accounting ratios.
• There is no standard set of ratios against which a firm’s ratio can be compared
27. Peer-to-peer financing
Peer-to-peer financing is the practice of borrowing and lending money between unrelated
individuals, or ‘peers’ without going through a traditional financial intermediary such as bank or
other traditional financial institutions. There is no necessary common bond or prior relationship
between borrowers and lenders. Intermediation takes place by a peer-to peer lending company
and all transactions take place online, with a view to the lender making a profit. Lenders may
choose which borrowers to invest in and the loans are unsecured. The emergence of new
intermediaries has proven to time and expenses.
28. Participants of financial markets
Major participants in financial markets include following:
• The individuals: They play the role of both savers and investors. Individuals directly make
investment in financial markets or channel their funds through banks or depositories
• Firms or corporates: Firms and corporates are borrowers in the financial markets. They
borrow funds from the public or banks to invest in different projects. Sometimes, they
invest their excessive funds in securities and money market instruments.
• Government: Governments are also major players in the financial markets. They borrow
funds from the public and from international organizations like World Bank to serve their
budget deficit. They collect revenue from the financial system in the form of taxes and
fees and invest in huge public infrastructures by themselves or via public enterprises.
• Regulators: Regulators regulate the flow of financial system. These are normally
government agencies that controls and supervise other participants in the financial
markets like Nepal Rastra Banks regulate banking system.
• Market intermediaries: Market intermediaries are major players in the financial markets
in various ways and roles. Banks, security dealers, investment companies, brokers, credit
agencies, depositories, portfolio managers, mutual funds, etc. all participate in financial
markets in various capacities and functionalities
29. NEPSE Index
The Nepal Stock Exchange is a value weighted index of all shares listed at the Nepal Stock
Exchange and calculated on a daily basis (for the days market remain open) at the closing price.
The calculation of the NEPSE index is based on the concept of the market capitalization which is
the sum of the market capitalization of all the company listed in the Nepal Stock Exchange. If the
ratio of current period market capitalization to the base period market capitalization is multiplied
by the multiplier 100, we get NEPSE index. This method of index calculation is called value
weighted method.
30. Risk and Uncertainty
In common parlance, the terms Risk and Uncertainty have synonymous meaning. However, they
differ from each other. Risk may be defined as the chance of future loss that can be foreseen. In
other word, in case of risk an estimate can be made about the degree of happening of the loss.
This is usually done by assigning to the probabilities of risk on the basis of past data and the

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 probable trends. Uncertainty may be defined as “the unforeseen chance for future loss or
damages.” In case of uncertainty, since the firm cannot anticipate the future loss, and hence it
cannot directly deal with it in its planning process, as is possible in the case of risk. For example,
a firm cannot foresee the loss which may be due to destruction of its plant in account of
earthquake.
31. Basic functions of financial management
The basic functions of the financial management are as discussed below:
• Procurement of funds – identifying the source of financing considering the risk, costs
and control.
• Effective utilization of funds – funds are used for beneficial ventures and not kept idle.
• Generation of reports for decision makers
• Preparation of financial reports
• Ensure proper financial accountability
32. Venture capital financing methods
Venture Capital financing refers to financing of high-risk ventures promoted by new qualified
entrepreneurs who require funds to give shape to their ideas. Here, a financier (called venture
capitalist) invests in the equity or debt of an entrepreneur (promoter) undertaking who has a
potentially successful business idea but does not have desired track record or financing backing.
Generally, venture capital funding is associated with heavy initial investment business like energy
conservation, quality up gradation or with sunrise sector like information technology.
Methods of venture capital financing:
• Equity financing
• Conditional Loan
• Income notes
• Participating debentures
33. Conflict in project choice using PI and NPV criterion
The conflict in project choice using PI and NPV criterion arises in case of mutual exclusive
projects of unequal investment size having different net present values because NPV gives
ranking on the basis of absolute amount whereas PI gives ranking on the basis of ratio. In such a
case, mutual exclusive project having highest NPV should be selected since it would increase the
firm’s wealth if the project is accepted which is consistent with the wealth maximization
objective of the financial management.
34. Application supported by blocked account (ASBA)
Application Supported by Blocked Amount (ASBA) refers to an application mechanism for
subscribing to initial public offers (IPO) or to Further public offering (FPO). The system which
ensures that the applicant's money remains in his/her bank account till the shares are allotted.
The applicant ‘s bank account will only be debited post allotment of the shares. The amount
debited depends on the shares/MF units allotted to the applicant and the remaining amount, if
any, is freed for use. SEBON has introduced ASBA system from Magh 2073. However, the option,
though available, is not mandatory for the investors. They can continue to make applications
through the existing facility of applying with cash/cheque. Prior to ASBA while applying in an IPO
or FPO, the entire amount had to be paid up front with the applications. In case there was no
allotment or part-allotment, the amount would get refunded to the applicant after 45-75 days.
This was a lost opportunity as the funds did not earn any interest during the period either.

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 However, if the application is made via ASBA, the funds stay blocked in the investor ‘s account,
but continue to earn the interest. Further, operational hassle of collecting and or depositing
refund slip can be avoided.
35. ‘Loan syndication is one of the project finance services.’ Discuss.
Loan syndication involves obtaining commitment for term loans from the financial institutions
and banks to finance the project. Basically, it refers to the services rendered by merchant
bankers in arranging and procuring credit from financial institutions, banks and other lending
and investment organization or financing the client project cost or working capital requirements.
Loan syndication is in fact a tie up of term loans from the different financial institutions. The
process of loan syndication involves various formalities such as:
• Preparation of project details,
• Preparation of loan application,
• Selection of financial institutions for loan syndication,
• Issue of sanction letter of intent from the financial institutions,
• Compliance of terms and conditions for availing of the loan,
• Documentation, and
• Disbursement of the loan.
36. Assumptions of economic lot size technique
Following are the assumptions of economic lot size technique:
• Constant Annual requirement of Cash
• Constant rate of demand of cash
• Constant Transaction costs
• Constant holding costs, and
• Zero conversion period
37. Cost and benefits of factoring
The cost of factoring includes:
• Factoring commission
• Interest charged by factor on advance granted

The benefits of factoring include:

• Saving in costs of in-house credit collection department

• Saving in bad debt losses
• Saving in cost of funds invested in receivables due to reduction in average collection
period
• Saving in cash discount allowed (if any)
38. Repurchase agreements
A repurchase agreement is an agreement to buy any securities from a seller on the
understanding that they will be repurchased at some specified price and time in the future.
However, since the length of any repurchase agreement (or „repo‟) is likely to be short, a matter
of months at most, it is customary to think of repos as a form of short-term finance and
therefore, logically, as being an alternative to other money market transactions. The effect of the
repo deal falls upon money market prices and yields, it is normal to regard such repos as money
market deals. In a repo, the seller is the equivalent of the borrower and the buyer is the lender.

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 The repurchase price is higher than the initial sale price, and the difference in price constitutes
the return to the lender. Deals are quoted on a yield basis.
Some repo deals are genuine sales. In these circumstances, the lender owns the securities and
can sell them in the case of default. In some repo contracts, however, what is created is more
strictly a collateralized loan with securities acting as collateral while remaining in the legal
ownership of the borrower. In the case of default, the lender has only a general claim on the
lender and so the margin is likely to be greater
39. Financial restructuring
Financial restructuring is carried out internally in the firm with the consent of its various
stakeholders. Financial restructuring is a suitable mode of restructuring of corporate firms that
have incurred accumulated sizable losses for / over a number of years. As a sequel, the share
capital of such firms, in many cases, gets substantially eroded / lost; in fact, in some cases,
accumulated losses over the years may be more than share capital, causing negative net worth.
Given such a dismal state of financial affairs, a vast majority of such firms are likely to have a
dubious potential for liquidation. Can some of these Firms be revived? Financial restructuring is
one such a measure for the revival of only those firms that hold promise/prospects for better
financial performance in the years to come. To achieve the desired objective, such firms warrant
/ merit a restart with a fresh balance sheet, which does not contain past accumulated losses and
fictitious assets and shows share capital at its real/true worth.
40. Ploughing back of profits
Long-term funds may also be provided by accumulating the profits of the company and
ploughing them back into business. Such funds belong to the ordinary shareholders and increase
the net worth of the company. A public limited company must plough back a reasonable amount
of its profits each year keeping in view the legal requirements in this regard and its own
expansion plans. Such funds also entail almost no risk. Further, control of present owners is also
not diluted by retaining profits.
41. Black-Scholes model
The Black-Scholes model is used to calculate a theoretical price (ignoring dividend paid during
the life of the option) using the five key determinants of an option's price viz; stock price, strike
price, volatility, time to expiration and short-term risk-free interest rate.
The model, though used by option traders, has a number of limitations, including:
• it takes no account of dividends payable on the shares during the life of the option
(though there is modified version to take these into account)
• it may only be used on European options (a fixed exercise date)
• it assumes a constant risk-free rate throughout the life of the option
• it assumes that the share price follows a random walk, and the possible share prices at
the end of any given period are based upon a normal distribution
• there are no transaction costs or tax effects relating to share or derivative deals
• it is possible to borrow at the risk-free rate to fund the underlying shares
• the difficulty in estimating standard deviation, to which the model is very sensitive, and
the use of this historic measure to estimate future movements.

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42. Private equity
Private equity is a mode of financing provided by private equity funds to a company for its
expansion, restructuring, refinancing or growth. Private equity fund provides needed capital in
the form of equity, debt or hybrid capital instruments for a particular period of time. Private
equity financed is recovered by private equity fund through structured repayments, another
private equity financing or public issue of equity shares. Private equity is an important source of
financing for companies where traditional sources of finance is not available, hence is also
termed as risk capital for the entrepreneurs. Many private equity funds also provide
management consultancy along with capital thereby helping company’s growth.
43. Book Building
Book building is a technique used for marketing a public offer of equity shares of a company. It is
a way of raising more funds from the market.
A company can use the process of book building to fine tune its price of issue. When a company
employs book building mechanism, it does not pre-determine the issue price (in case of equity
shares) or interest rate (in case of debentures) and invite subscription to the issue. Instead, it
starts with an indicative price band (or interest band) which is determined through consultative
process with its merchant banker and asks its merchant banker to invite bids from prospective
investors at different prices (or different rates). Those who bid for the process are required to
pay the full amount. Based on the response received from investors the final price is selected.
The merchant banker (called in this case Book Runner) has to manage the entire book building
process. Investors who have bid a price equal to or more than the final price selected are given
allotment at the final price selected. Those who have bid for a lower price will get their money
refunded.
The greatest advantage of the book building process is that this allows for price and demand
discovery. Secondly, the cost of issue is much less than the other traditional methods of raising
capital. In book building, the demand for shares is known before the issue closes. In fact, if there
is not much demand the issue may be deferred and can be rescheduled after having realized the
temper of the market.
44. Pecking order theory
The pecking order theory of corporate capital structure developed by states that issuing
securities is subject to an adverse selection problem. Managers endowed with private
information have incentives to issue overpriced risky securities. But they also understand that
issuing such securities will result in a negative price reaction because rational investors, who are
at an information disadvantage, will discount the prices of any risky securities the firm issues.
Consequently, firms follow a pecking order: use internal resources when possible; if internal
funds are inadequate, obtain external debt; external equity is the last resort. Firms simply use all
their internally generated funds first then move down the pecking order to debt and then finally
to issuing new equity, firms follow a line of least resistance that establishes the capital structure.
Internally generated funds- i.e., retained earnings:
• Already have the funds
• No issue costs
• Do not have to spend any time to collect the fund.

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 Debt

• Moderate issue costs

• The degree of questioning and publicity associated with debt is usually less than that of
equity shares
• Cost of fund is also low.

New Equity Shares

• Expensive issue costs

• Cost of fund is significantly high
• Extensive questioning and publicity associated with share issue
45. Criticism of Wealth Maximization
Criticism of Wealth Maximization are:
• Wealth maximization leads to prescriptive idea of the business concern, but it may not
be suitable to present day business activities.
• Wealth maximization can be activated only with the help of the profitable position of the
business concern.
• Wealth maximization is nothing, it is also profiting maximization, it is the indirect name
of the profit maximization.
• Wealth maximization creates ownership-management controversy.

The ultimate aim of the wealth maximization objectives is to maximize the profit.

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